Editor’s note: The following is a guest perspective by Patrick F. Stone, president and CEO of Williston Financial Group, which is parent to WFG National Title Insurance Co. His contribution focuses on the Federal Reserve’s announced plans for a new round of quantitative easing.
By PATRICK F. STONE
Below are some thoughts on the Federal Reserves’s "Quantitative Easing 2" plan (or QE2): the reasoning, size, objective and outcome. Please understand that my comments are conjecture, and do not represent inside information or unique thinking. I have had a lot of conversations with economists and Wall Street players, and while there is a uniform belief as to the rationale behind easing, there is no consensus as to the size or outcome.
I expect "Quantitative Easing 2" (or QE2) will be implemented on a "stepped in" basis: perhaps $300 billion to $500 billion initially, followed by additional commitments as necessary. The impact will be meaningful for residential real estate, with at least a stabilization of prices through a rate-induced increase in demand (4 percent or lower 30-year-fixed mortgage rates).
If the Fed is committed to increasing inflation, and I believe it is, the resultant upward pressure in asset prices will impact real estate. Such an effect will cause an uptick in home prices and an increase in personal wealth, refinance and purchase activity, and finally, new construction when the overhang of inventory is absorbed.
While it is difficult to estimate the length of time necessary to create the impact, once inflation at or above 2 percent annually takes hold, the effects on real estate should start to take hold, and be magnified by time and increases in inflation.
REASONING: Deflationary trends in core Consumer Price Index and an uncomfortable emerging parallel with the Japanese experience. Fed Chairman Ben Bernanke is a student of the Great Depression, and of Japanese economic history, and does not want to see the U.S. replicate either experience.
While some would argue that commodity prices (and gold) have escalated, and that there is more of a threat of inflation than deflation, those in the real estate industry see the impact of "deflationary expectations" in the form of reluctant homebuyers who are waiting for values to fall further. (See attached slides.)
SIZE: This is the $64,000 question — or is it a $1.5 trillion question? Smart money says $500 billion to start, and more as needed.
OBJECTIVE: Drive long-term rates down (short-term rates cannot go much lower). There is no stated goal as to how low the Fed wants to see long-term rates, but it is safe to assume that any meaningful change would cause 30-year-fixed rates to dip below 4 percent. Exactly how far is purely a guess.
The question here is at what interest-rate level does mortgage lending become problematic in terms of profitability for originators or those holding the loans (the government-sponsored entities and banks). I can’t imagine too many people wanting to hold 30-year paper paying 3 percent.
OUTCOME: As the driving rationale is to reinflate the economy, inflation of real assets is the desired outcome.
We have seen meaningful increases in commodity prices and stock prices in anticipation of QE2. With the implementation of QE2, and the hoped-for inflation, house prices will stabilize and — depending on the degree of impact and length of impact — housing inflation is a logical byproduct. Any meaningful housing appreciation will have a tremendously positive impact on the economy by affecting the following:
1. It will increase homeowners’ perception of net worth (wealth).
2. It will stop deflationary expectations with regard to house prices, and with reported price increases it will very quickly turn fence-sitters into homebuyers.
3. It will tee up further refinancing, and continue to lower homeowners’ monthly payments … and by implication, increase their spending power and hopefully their consumption.
4. It will create a positive environment for new homes and result in new construction and meaningful gains in employment.
While it is doubtful that the Fed will come right out and say it, it appears that "fixing" residential real estate would be a desirable outcome, if not the most meaningful outcome, of QE2. The potential outcome of this strategy is hard to quantify, but getting inflation going will be difficult.
We have tremendous unused capacity in the economy, and as everyone knows, unemployment is very high. The correlation between the amount of money in the system and inflation is not as high as the correlation between capacity utilization and inflation.
Patrick F. Stone is president and CEO of Williston Financial Group, which operates WFG National Title Insurance Co., based in Lake Oswego, Ore. He is chairman of The Stone Group, a commercial brokerage and development company, and is a former president and chief operating officer and director for Fidelity National Financial.
